Suit in 38 Studio debacle is shortsighted

Posted
Thursday, December 6, 2012 1:00 pm

John Hazen White, Jr.

Like the first traces of snow on the ground to signal winter’s arrival, the fallout from the 38 Studios disaster is beginning to be felt in the Ocean State. Yet another state-by-state ranking – this one by the 24/7 Wall Street blog, has listed Rhode Island as the second worst run state in the country right now (after California, which has been publicly compared to Greece, because of its debt burden).

The 24/7 Wall Street blog, which provides “analysis and commentary for U.S. and global equity investors,“ summarized the state’s negatives in arriving at the dismal 49th ranking: $9.5 billion in public debt, one of the worst debt burdens in the country, amounting to $9,000 per person, and a failed loan guarantee for 38 Studios that represents “ a spectacular example of fiscal mismanagement.”

The 38 Studios debacle is going to dog Rhode Island for years to come. First, there’s the $110 million we owe to the holders of the bonds the EDC floated. Payments on those bonds will soon start to come due, and will weigh on the annual deficits the state faces ($130 million next year and bigger annual debts to follow). Then there’s the legal storm that is forming. The state is taking legal action in the form of indictments against those within 38 Studios and the EDC that it is holding responsible for the gaming company’s collapse. Those lawsuits allege fraud, negligence and legal malpractice against 14 individuals, including Curt Schilling and the EDC’s former director, Keith Stokes. A first hearing on the state’s allegations will occur in January.

House Speaker Gordon Fox, who survived a tough reelection challenge that focused on his role in the 38 Studios deal, has pledged to open oversight hearings to focus on what happened within the EDC in vetting and approving the deal. He has promised “substantive and thorough” hearings, but he will want to steer the inquiry away from the actions of the General Assembly leadership, if he can, in shepherding the final $125 million loan legislation, of which 38 Studios was quietly designated to receive the lion’s share. Assembly members, to include Democrats, are on record as saying they had no idea that they were voting for a secret deal for 38 Studios inside the legislation.

In the meantime, auctions of 38 Studios’ physical assets have netted a pittance – less than a million dollars - and while the company’s intellectual properties may be worth additional monies, the total amount clawed back will be negligible overall. The state’s lawsuit won’t bring back much either: even if the state can convince a jury to convict, which is debatable, Schilling will probably have filed for bankruptcy already and the other defendants may well be acquitted.

The fact that Governor Chafee, who brought the lawsuit, declared a desire to sue members of the EDC board when he was a candidate for governor, even before 38 Studios ran into trouble, may be construed as prejudicial before a jury. Remember, even though he opposed the deal in the first place, Chafee, as Rhode Island’s elected chief executive, had a duty to husband the enterprise along and watch out for taxpayers’ risk. He appears to have learned of the company’s troubles when it was too late to save it, and he refused to bail it out when it was short on its first repayment, forcing it to default.

Taking legal action against Schilling, Stokes and the others is shortsighted and, as has been suggested, may do more harm than good. First, it’s not going to recoup any significant money to help pay off the bond obligation; the lawsuit may collapse under its own weight (there has been no evidence of financial chicanery within 38 Studios that’s come to light thus far, and the state appears to have forced the company to ramp up its employment too fast). And it will surely send a cold, cautionary message to entrepreneurs and other businesses considering setting up shop here, that doing business in Rhode Island - and doing business with the state of Rhode Island – could be a dicey proposition.

One thing the Governor is right about: we cannot default on the bonds. It’s not helpful that former Governor Don Carcieri, who had a huge, largely unexamined (to date) role in the 38 Studios affair, has suggested otherwise. As a former banker he should be the first to understand the consequences that would accrue to a state that defaults on bonds it legally assumed. But then again, as a former chief executive of Cookson America, one would have thought that he would have been wary of throwing so much money at a fledging video game venture led by a retired baseball player with zero business experience beyond signing autographs and collecting WWII memorabilia and gold coins.

The sad fact that hangs all over the 38 Studios deal is the heavy-handed, backroom deal-making among insider politicians who first pressured the EDC to approve the deal, and then masterminded a legislative sneak attack that pushed through an opaque small business funding program in which most of the money was assigned to one company, which just happened to be owned by a Red Sox hero. Notoriety and star-power easily opens doors, and makes otherwise sane, prudent men do things that result in “spectacular mismanagement” of taxpayer money.